The mortgage crisis showed that some residential mortgage lenders weren’t doing a good job of keeping careful records and communicating with borrowers. Some of this affected all borrowers, but the worst effect was that some people who could have worked out their problems with the right help, lost their homes. Congress has told the Consumer Financial Protection Bureau (CFPB) to adopt new federal regulations to avoid this in the future. On this site, you can read about the new proposals, react to them, and discuss them with others. What you say here will make a difference: CFPB is required to consider public comment before making a final decision, and it will get a detailed summary of what Regulation Room commenters have to say.

For All Borrowers: Adjustable Rate Mortgages

§1. Warning about the first rate adjustment

In an “adjustable rate mortgage” (ARM) the borrower agrees to pay an interest rate that can change from time to time, over the life of the mortgage. The introductory rate (sometimes called a “teaser rate”) is usually lower than the interest rate of a fixed-rate mortgage. In the years leading up to the mortgage crisis, lower initial payments allowed some borrowers to qualify to buy a more expensive house, and ARMs became very popular. What got some borrowers into trouble was “payment shock.” When the interest rate adjusted after the teaser rate expires, the borrower might suddenly have to make much higher payments. (Payment shock can also result from other kinds of ARM that are described later in this post.) CFPB is proposing new disclosure forms that make clearer to borrowers what is going to happen when their interest rate adjusts, in enough time that they can take steps to lessen payment shock and avoid getting into trouble on their mortgage (e.g., refinancing, budgeting their money differently).

What this means for consumers: Between 7 and 8 months before the borrower must make payments under the first interest rate adjustment, he/she would receive a disclosure like this:

The sample form has several features not found in all ARMs, but very important to borrowers if they do apply.

The “Rate Limits” section describes a loan in which the interest-rate increase for any single adjustment is capped, but an amount over the cap can be carried over to the next adjustment

The “Prepayment Penalty” describes a feature in some ARMs that penalizes the borrower for paying off the loan principal early by, e.g., refinancing. Disclosing the amount of any prepayment penalty should help the borrower decide whether, given the adjusted payment amount, he/she would still be better off by refinancing even with paying the penalty.

CFPB is trying to strike a balance between giving borrowers as much useful information as possible, but not overwhelming them with too much detail. Does the sample form get it right? Are there changes that would make it clearer?

Notice that the new payment is likely to be only an estimate (remember that this comes 7-8 months in advance and adjustments are almost always based on some financial index that keeps changing, e.g., LIBOR, prime rate). If the servicerdoes have the exact new rate and payment amount, this information must be given. If not, it will have to send a second notice with the information at least 2 months before the first new payment is due. (See the next section of this post.)

Interest-only ARMs: With some ARMs, it may turn out that the new payment amount will cover only interest and not any of the principal. If this happens, the notice must state: “[M]aking this payment will not reduce your loan balance. In order to fully pay off your loan by the end of the loan term at the new interest rate, you would have to pay $XXXX per month.” CFPB has found that consumers are very confused about these kinds of loans. It’s not sure that most borrowers are helped by telling them how much they would have to start paying in order to pay off the mortgage by the end of the current loan term, at the new interest rate. It’s considering deleting this sentence from the notice. What do you think?

Negative-amortization ARMs: With some ARMs (especially payment-option loans), it may turn out that the new payment amount won’t cover even all the interest on the loan. If this happens, the notice must state: “Warning about Increase in Your Loan Balance: Your new payment covers only part of the interest and no principal. Therefore, the unpaid interest will add to the balance of the loan or will increase the term of your loan. In order to fully pay off your loan by the end of the loan term at the new interest rate, you would have to pay $XXXX per month.” Again, CFPB wants to hear whether the information in the last sentence really helps consumers.

Is there a better way to help borrowers understand these kinds of ARMs?

Many servicers will be required to send borrowers a detailed statement about the status of their loan every payment cycle. See the Periodic Statement post. Should servicers combine the ARM disclosure with the periodic statement?

What this means for servicers (and creditors and assignees): ARM disclosures are now exempt from the general disclosure requirements of Regulation Z. CFPB proposes to change this. It believes that current notices don’t contain all the information borrowers need, and don’t sufficiently bring ARM information to consumers’ attention. The new rules would require additional content, as well as specific presentation format for ARM material. CFPB’s consumer testing has shown that the proposed format changes increase borrowers’ ability to understand the information.

In the new rules, ARM generally means the same thing as “variable-rate mortgage” in current Regulation Z. For exceptions see CFPB commentary 20(d)(1)(ii)-2. Also, the new rules would apply to all closed-endARMs, not just hybridARMs, since the payment shock problem is the same. (They would not apply to open-endARMs such as home equity loans because these are covered by parts of Regulation Z not involved in these proposals.) The current exclusion of short-term ARMs would be deleted, although construction loans of one year or less would be exempted. Are there other short-term ARMs that should be exempted? Will a 60-day minimum notice period work for such loans?

The new rules would apply to all servicers and owners, including assignees (unless they no longer own or service the loan.) CFPB believes that not including assignees would leave a hole in consumers’ protection and give assignees an unfair advantage over creditors. The servicer and the owner can coordinate efforts so that only a single notice is sent to the borrower.

The required timing of the initial notice is at least 210, but no more than 240, days before the date on which the first payment at the adjusted level is due. If the first adjustment comes within 210 days of closing, the notice must be provided at closing. These times exclude any grace period. Small servicers questioned the value to consumers of a notice given so far in advance, since it is likely to be only an estimate; they also are concerned about the cost of developing and providing these notices. One suggestion was to exempt small servicers. Another was not to require the second notice that contains the actual rate and new payment amount. CFPB thinks the first notice is needed to give borrowers time to take steps to avoid or lessen payment shock. The second is needed to give borrowers the exact rate and new payment amount. CFPB wants comments on whether the burden on small servicers outweighs the value of the notices to consumers?

Note that although the notice calls for a “good faith estimate” of the new rate and payment amount, CFPB is specifically proposing that good faith requires disclosing the actual rate and amount if these are known to the servicer at the time of the notice.

CFPB proposes to change how housing counselor information is provided. Rather than listing specific organizations with contact numbers, the ARM disclosure would have to give the website and phone number for either the HUD Approved Counseling Agencies list, or a list that CFPB will develop, as well as the state housing finance authority for where the borrower resides.

Current law permits servicers to comply with other federal agency regulations for ARM disclosures instead of those in Regulation Z. Since CFBP doesn’t know of any such comprehensive requirements, it proposes to delete this provision and make these new notice requirements exclusive. Is there any reason to retain an alternative compliance provision?

§2. Alerts when the payment amount changes

ARMs usually adjust interest rates many times over the life of the loan. Borrowers would get a notice every time the rate adjusts and produces a change in payment amount. The sample form is similar to the initial rate disclosure:

This notice must be sent 2-4 months before the new payment is due. (If the borrower has an ARM that adjusts within 60 days of closing and he/she didn’t get the actual new rate at closing, the disclosure must come as soon as practical, but at least 25 days before the new payment is due.) No notice would be required if an adjustment won’t change the buyer’s payment. CFPB thinks the new periodic statement provides enough information about the ARM if there is no change in payment amount. See Periodic Statement § 2. Is there any reason to send a separate disclosure form if the payment amount isn’t changing?

What this means for servicers (and creditors and assignees): A notice would be required for ARMs that convert to fixed-rate mortgages when a payment change results. For open-end loans converting to closed-endARMs, disclosure is not required until an adjustment results in a payment change. In general, CFPB’s proposal not to require notices unless payment amount changes will lessen the current regulatory requirement of annual notices. Also, if the first rate adjustment happens within 210 days of closing and the initial rate adjustment disclosure provided the actual (not estimated) rate and payment amount, a second notice need not be sent.

Now, the law permits servicers to send notice as little as 25 days before the new payment is due. CFPB thinks 25 days is not enough time for borrowers to take steps to lessen any payment shock, which is why it is proposing notice at least 60 days in advance. CFPB has learned that small servicers often notify borrowers farther in advance than large servicers. It wants to know how servicers will have to change their operations to meet a 60-day rule. What are the costs of storing and accessing loan-specific information? What factors, if any, would hinder compliance?

CFPB recognizes that for mortgages with very short look-back periods, a 60-day requirement could be burdensome. It proposes to grandfather ARMs with a look-back period of less than 45 days that are created before a date that is 6 months after the effective date of § 1418 of the Dodd Frank Act.Should any ARMs be grandfathered? If so, what should the criteria be? Is it feasible to apply a 60-day requirement to loans with less than a 45-day look-back period?

Most of what was said about the initial rate disclosure applies here as well. As with the initial notice, more information would have to be provided, in a particular format. Servicers will want to review the details of required content for this disclosure. The information must be in a separate statement, but this could be sent to borrowers in the same envelope (or email) as the new periodic statement. (See the Periodic Statement post.)

Welcome to Regulation Room, nancy sanders, and thank you for your comment. CFPB’s proposed rule would require that this notice be given 60 days before the new payment is due, not 60 days before the rate changes. CFPB recognizes that some servicers may have to change their practices to meet this new requirement. With all that in mind, do you think that this time frame could work?

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Strongly support the concept of advanced notice on the “price shock”. It will not however save the consumer from a questionable prior financial decision (ARM, negative amortization). That is why presenting the critical information upfront, in a standard form single page 10-12point font that emphasizes the reality of the financial agreement they are being presented with, is the real practical force & effect of this rule secrion. E.g. “your mortgage will increase if you only pay x”

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The sample form is a working draft I hope. Keep working towards streamline, and developing a matrix/table form that presents the information that the consumer cares about most.
PRIORITY INFORMATION, TABLE #1″how much& how soon & present balance & 1-2 scenarios for principle balance after next successful payment”
PRIORITY INFORMATION, TABLE #2 “rate benchmark, past/present/projected rates & cost differential for the monthly payment based on the current vs. projected rate”

PRIORITY #3: All the background and explanations…

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The additional communications, as proposed on this site, are a good thing, of and by themselves. However, I believe there is another problem that should be addressed, in addition.

I suspect that many people who take out an ARM do not fully consider the risk of future rate increases. Especially with the currently low rates (and potential for higher long-term inflation), ideally a prospective customer should perform a “stress-test” on their own financial situation, and ask realistically could they afford the loan if rates climb in the long term, and specifically how they would accomplish this. An alert is nice, but the options are far greater before the agreement is signed.

Therefore, my recommendation would be to put equal–or greater–emphasis on clear communication… more »

…and discussion of options before the loans are signed, with a focus on worst-case increases. e.g. “If rates do climb substantially, and your ARM rate goes to it’s highest allowed level of __X%__, your monthly payment would be __$xx,xxx__. In that scenario of higher rates (and likely higher inflation), what would you have to do to ensure you can still make payments?”

Even if the prospective customer doesn’t provide an answer to the loan officer, that might trigger some very useful discussions among spouses, co-signers, etc.

(I assume that lenders would detest such a requirement, but fundamentally we do need to enforce reality-checks at some stage: history and basic logic indicate that the people who are paid to generate loans are not the best guardians of long-term risk.)

Another way to make prospective customers more aware of the risks would be to ask “Assuming your loan payments do increase steadily if rates rise, at what level (of monthly payment dollars) would you need to either sell the house, allow foreclosure, or request modification of terms?” (i.e. how much of an increase could you really afford.) Requiring a prospective borrower do the math might be a useful reality check – even if the person fudges the numbers, at least the issue will have been implanted in their head. « less

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Hi prestonsherwood, and welcome to Regulation Room! This rule only deals with what happens when people already have a mortgage. CFPB is proposing a separate regulation about pre-disclosure, which you can find here. For people who already have an ARM, do you think the information in CFPB’s proposal makes sure homeowners get the information they need?

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I think the form is a great start. I suggest (1) making the the items that propose the Alternatives i.e. refinance, modification etc. to be placed in bold as well because they are important options. (2) Reminding consumers that there are various websites, such as bankrate.com that can give them information about prevailing rates. (3) putting a representative pict of a posted libor rate from wsj. Also is giving the notice 2-4 month before increase really enough time to sale a home? Is it possible to allow consumers another 2-4 (for a total of 6 mos to sell) if they choose the sale option before the price increase takes affect?…. just a thought.
Finally I suggest putting as many explanatory items in bullet form instead of paragraph form. Thank you.

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Welcome to Regulation Room, steve smith. As you recognize, the Consumer Handbook on Adjustable Rate Mortgages is not at issue in this proposed rule. However, disclosures that consumers receive before getting a mortgage are at issue in another one of CFPB’s proposals. You can read more about that rule and find a link to comment on it here. Also, if you would like to file a complaint with CFPB regarding how you didn’t receive the handbook, you can do that on CFPB’s website.

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Thank you Moderator. Honestly, is there any value to filing a complaint at the CFPB’s website from a foreclosure that took place in 2009? I’ve contacted and filed a complaint with every office in this country and wound up with a response stating, ” Thank you for informing us but there’s nothing we can do. Go find a lawyer.”

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Steve smith, here is a brochure containing more information on how the CFPB handles complaints. What also might be helpful is the information under “How Do You Handle Complaints” on CFPB’s Consumer Complaint Database.

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The wording does not get it right. When our family went through this, the people representing the lender told us: “don’t worry about ARM’s, you can always refinance later” Of course, once the collapse hit, refinancing became not an option for many. The wording should specifically say something like: “WARNING: you may not be able to refinance later, so you should expect to have to make the higher rate payments later”

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Thank you for sharing your story, mark.homer.50, and welcome to Regulation Room. CFPB is certainly interested in giving ARM borrowers opportunities to refinance and more information about refinancing. Do you think that having earlier notice of the first rate change and more information regarding prepayment penalties would have helped people in the situation you described?

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